LIBOR

This has been taken from our blog,”Brinks of economic thoughts”

LIBOR

 

This was written by me during the time when LIBOR crisis had shaken the financial markets.

 

LIBOR [LONDON INTER BANK OFFERED RATE].

 

This is the rate at which banks in London  lend money to each other for short-term in a particular currency. A new LIBOR rate is calculated every morning by financial data firm Thomson Reuters based on interest rates provided by members of British Banker ’s  Association [BBA].

 

This rate officially came into existence in 1984. LIBOR  rates are calculated  and published daily at 11;30 a;m [GMT] by Thomson Reuters.

Every day a group of  leading banks submit rates for 10 currencies  and 15 lengths of loan[borrowing periods] ranging from overnight to one year .It is a global bench mark interest rate used to set a range of financial deals. It is also a measure of trust in financial  system   and faith banks have in each other’s financial health. LIBOR is used to set arrange of financial transactions  worth an estimated $ 800 trillion which is equal to 12 times of global GDP. Many financial institutions , mortgage  lenders  and credit –card agencies set their own rates relative to it.

 

As early as 2005 there was evidence that Barclay’s had tried to manipulate dollar LIBOR at request of it’s derivative traders and other banks. It was clearly in 2008,Wall Street Journal published a report that questioned integrity of LIBOR.

 

It was in 20009 BBA had circulated guidelines for all contributor banks on setting   LIBOR rates in same manner. Barclay’s made no change to it’ s system to take account of BBA guidelines .Important rules as such of having distinction between derivatives team and submitters were violated.

 

It was finally in JUNE 2012, Barclay’s admitted to misconduct. The UK’S FSA imposed a euro 59.5 mn penalty.FSA[Financial service authority],US Department of Justice of Commodity futures trading Commission [CFTC]imposed fines worth euro 102 mn and euro 128 mn respectively ,thus way forcing Barclay’s to pay a total of around  euro 290 mn.

 

 

When financial crisis peaked in late 2007,many banks stopped  lending to each other over concerns about their financial health with some banks submitting much higher  rates than others.  Barclay ’ s  was the bank which was submitting higher rates. This prompted rumours that Barclay’s was in trouble. This followed a series of internal debate and controversial conversation with bank of England official, Barclay’s began to submit much lower rates. A bank has to pay a higher interest rate to borrow funds if other lending banks have less confidence in it.

Mechanism  with which LIBOR was fixed.

 

Bank submit rates

 

            A                                 B                                     C                                  D

 

            1%                               2%                                    3%                            4%

 

 

Lower bottom is discarded-

 

 

            1%                                 2%                                   3%                            4%

 

 

Avg. is calculated of remainder-   2.5 % This is LIBOR.

 

 

In same way rates if submitted by 16 banks were considered ,lower and upper 4 rates ,means overall 8 rates were discarded and average of rest 8 were calculated on which transactions took place.

 

As a consequence  of  it, those paying interest on loans would have benefitted from lower LIBOR rates, savers and investors would have lost out.

Barclay’s had to pay $ 453 million to settle U.S and British authorities’ allegations that British bank had tried to manipulate London interbank offered rate.

 

Barclay’s was not be the only bank put through wringer over question of rate manipulation .Barclay’s  also likely to faced civil cases, as customers on wrong side of LI BOR  movements bring claims.  at least   12 banks were involved in LIBOR investigations  around the world. Fines on Barclay’s may heralded similar penalties on others.

 

Investigations of more than a dozen bank by authorities on 3 continents  started   to   unearth evidence  that some banks improperly  sought to alter LIBOR.

 

Now it is a another case of globally working trade .Analysts said industry  may have to shell out billions of dollars to settle the cases and other  bank chiefs could find themselves in troubles.

Roughly a  dozen  banks acknowledged being under criminal or civil investigation in various countries in the matter.

MORE THAN $  800tn in securities were linked to the Libor ,including $ 350 tn in swaps & 10 tn $ in loans ,including home and auto loans. These transactions take place globally.

 

Britain’s financial services industry is a national asset. It has thrived for many reasons that include London’s   favourable  time –zone, that allows it to trade with Asia and  America .It was a fact of great prestige that Britain did effectively set interest rates for rest of world .As of now Britain’s ability to play by and police the rules is under scrutiny.BBA[British Banker’s Association] is considering a LIBOR revamp. Instead of  estimated  rates actual rates are considered to be used.

 

 

Harsh Vardhan Pathak

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